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Under Armour: Profits Are No Sweat...For Now

Walk through the apparel sections of sporting goods stores like Dicks or Modell's, and you'll see stuff by Under Armour displayed front and center. The company's famous moisture-wicking fabric is stretched over imposing, muscled mannequins, and is festooned with similarly imposing price tags. T-shirts start at $20 and run up to $60 with all the bells and whistles, and even a plain polo shirt can cost $50.

Seeking to cheat the system, I looked on eBay for some Under Armour sweatpants a couple of months ago, and found they weren't much cheaper than what I would have to pay in stores. Moreover, the selection on eBay was poor. Given that eBay is the ultimate litmus test for how well a company controls its channels, Under Armour is master of its retail domain.

This is an amazing success story. The company, which started in Maryland in 1996, had sales of just $20 million five years ago. Analysts predict that sales will reach almost $600 million in 2007. The name has such cache among athletes -- pro, amateur, child and hack -- that Under Armour can make inroads into new apparel lines almost at will. For example, it started selling football cleats last year and already has 20% of the market, according to Morningstar. Moves into outdoor clothing and women's clothing plus expansion in Europe lead analysts to forecast sales in excess of $1 billion in 2010.

As rugged as its gear is, though, Under Armour's stock seems as delicate as a hot-house flower. On June 20, after UBS analyst Jeffrey Edelman initiated coverage with a "buy" rating, the stock soared almost a buck a share. It ended the day at $46.35, up 53 cents a share, a solid showing in a weak market. Other analyst reports have moved the stock up and down significantly.

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The stock is unstable because it's so expensive relative to the company's profits. With analysts expecting earnings of 95 cents per share this year, the stock (symbol UA) trades at 49 times earnings. On next year's average estimate of $1.25 a share, the P/E is 31. So any news, good or bad, will easily fan the fires of greed or fear.

And there's a lot to be greedy and fearful of. Although Under Armour is likely to continue to generate strong sales growth, a couple of factors could sink profitability. Advertising costs to keep Under Armour mania hot sometimes knock down profits unexpectedly, as happened in the first quarter of 2007. And anyone can make the basic fabric that makes Under Armour special -- the technology isn't patented.

I ended up buying the Nike version of moisture-wicking sweatpants on eBay for $15 less than the price tag on the Under Armour brand. Under Armour's entire marketing budget is a rounding error for a company such as Nike, which had sales of more than $16 billion for its fiscal year that ended in May. If Nike gains traction in its battle against Under Armour, expect to see Under Armour's fat profit margins shrink steadily.